February 10, 2011

The SEC Has Its Say on “Say on Pay,” “Say on Frequency” and “Say on Golden Parachutes”

On January 25, 2011, the Securities and Exchange Commission (the “SEC”) issued final rules to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) related to: 

  • shareholder advisory votes on executive compensation (“say on pay”); 
  • shareholder advisory votes on the frequency of conducting say-on-pay votes (“say on frequency”); and
  • disclosure requirements and shareholder advisory votes on compensation arrangements in connection with mergers and certain other significant corporate transactions (“say on golden parachutes”).

The rules are generally effective as of April 4, 2011.  However, the Dodd-Frank Act requires public companies to implement the say-on-pay and say-on-frequency advisory votes with respect to proxy statements for annual meetings of shareholders occurring on or after January 21, 2011.  Due to a temporary exemption adopted by the SEC, a “smaller reporting company” will not be required to conduct say-on-pay or say-on-frequency votes until its first annual meeting on or after January 21, 2013.  Companies are required to comply with the new rules regarding golden parachutes with respect to filings made on or after April 25, 2011.

Shareholder Advisory Votes 

 In accordance with the Dodd-Frank Act, the new rules require public companies to conduct three different types of shareholder advisory votes as follows:

  • Say-on-pay vote.  A company must provide its shareholders with the opportunity to vote on the company’s executive compensation at least once every three calendar years.  The say-on-pay vote will relate to the compensation of the “named executive officers” as disclosed in the proxy statement pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis section (“CD&A”), the compensation tables and the other narrative disclosures regarding executive compensation. 
  • Say-on-frequency vote.  A company must provide a separate shareholder vote to determine the frequency of say-on-pay votes.  The proxy card must provide shareholders with four choices on this say-on-frequency vote:  every one, two or three years, or abstain.  The board of directors may include a recommendation as to how shareholders should vote on the say-on-frequency proposal.  This say-on-frequency vote must be included in the company’s proxy statement at least once every six calendar years. 
  • Say-on-golden parachutes vote.  The rules also provide for the inclusion of a separate shareholder vote on certain golden parachute arrangements in proxy statements for meetings at which shareholders are being asked to approve a merger or similar transaction.  A company will not be required to include a say-on-golden parachutes vote in its proxy statement if the golden parachute arrangements were the subject of a prior say-on-pay vote. 

All of the shareholder votes described above are advisory in nature and, therefore, are non-binding on the company.

Form 8-K and Other Say-on-Pay/Say-on-Frequency Disclosure

In connection with the new rules, the SEC amended Form 8-K to require a company to disclose its decision regarding how frequently it will conduct shareholder advisory votes on executive compensation following each say-on-frequency vote.  To comply with this requirement, a company will file an amendment to its prior Form 8-K filing that reported the results of the say-on-frequency vote.  Thus, a company will be required to file:

  • a current report on Form 8-K under Item 5.07 within four business days following its annual meeting of shareholders (or special meeting in lieu thereof) to report the results of its initial say-on-pay and say-on-frequency votes; and
  • an amendment to that report to disclose the action it will take on the say-on-frequency vote. 

This amendment will be due no later than 150 calendar days after the date of the meeting, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals as disclosed in the company’s proxy statement.  The failure to file the amendment to Form 8-K in a timely manner will result in the loss of a company’s eligibility to file registration statements on Form S-3. 

In addition, the rules will require companies to disclose in their subsequent proxy statements the current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur.  A company also will be required to address in the CD&A whether and, if so, how the company’s compensation policies and decisions have taken into account the results of the most recent say-on-pay vote. 

Disclosure Regarding Golden Parachutes

In addition to requiring a say-on-golden parachutes vote, the rules also prescribe specific disclosure requirements for “golden parachute” arrangements in filings for the following transactions:  an acquisition, merger, consolidation or a proposed sale or other disposition of all or substantially all assets; a Rule 13e-3 going-private transaction; or a third-party tender offer.  In general, golden parachute arrangements include any agreements or understandings that the target company or acquiring company has with the named executive officers of either company, concerning any type of compensation that is based on or otherwise relates to the transaction. 

These disclosure requirements are more detailed than the change of control disclosure currently required in proxy statements for annual shareholder meetings.  In addition, while companies generally include disclosure regarding golden parachute arrangements in transaction-related disclosure documents, the rules require both specific types of disclosure and a specific format for the disclosure.  In particular, the rules require disclosure of any golden parachute arrangements of the named executive officers in both tabular and narrative formats. 

The new table requires quantitative disclosure of the individual elements of compensation that the named executive officers would receive that are based on or otherwise relate to the transaction (e.g., cash severance, equity acceleration, perquisites and other personal benefits, tax gross-ups, etc.).  The table also includes a column for the total golden parachute compensation for each named executive officer.  Among the narrative disclosure requirements, companies must describe any material conditions or obligations applicable to the receipt of a golden parachute payment, the specific circumstances that would trigger payment, whether the payments are to be made in a lump sum or installments, the duration of the payments and by whom the payments will be provided.

Because the say-on-golden parachutes vote is only required when proxies are being solicited with respect to a proposal to approve a merger or similar transaction, there are contexts in which a company will be required to comply with the new disclosure rules regarding golden parachute arrangements, without a related shareholder vote.

Additional Considerations

  • Impact on shareholder proposals.  The SEC revised the rules regarding shareholder proposals to permit the exclusion of a proposal that would provide a say-on-pay vote, seeks future say-on-pay votes, or relates to the frequency of say-on-pay votes if the company adopts a policy on the frequency of say-on-pay votes that is consistent with a majority of the votes cast on the most recent say-on-frequency proposal.  Given that the say-on-frequency vote provides three substantive choices to shareholders, it is possible that no single choice will receive a majority of the votes.  Thus, a company may not be able to exclude subsequent shareholder proposals regarding say-on-pay matters even if the company adopts a policy on frequency consistent with the plurality of shareholder votes.
  • Preliminary proxy statements.  The filing of a preliminary proxy statement will not be triggered solely by the solicitation of proxies with respect to an advisory vote on executive compensation, including a say-on-pay or say-on-frequency vote.  As a transition matter, the SEC will not require a preliminary filing prior to the new rules becoming effective due to the inclusion of say-on-pay and say-on-frequency proposals in a proxy statement.
  • Broker discretionary voting.  The New York Stock Exchange and NASDAQ have adopted amendments to their rules that prohibit broker discretionary voting of uninstructed shares with respect to say-on-pay, say-on-frequency and say-on-golden parachutes votes.  Broker discretionary voting had already been eliminated for elections of directors and votes on other compensation-related matters, such as equity plans.
  • Reporting of votes by institutional investment managers.  Under the Dodd-Frank Act, institutional investment managers will be required to report at least annually how they voted on any say-on-pay, say-on-frequency or say-on-golden parachutes proposal, unless such vote is otherwise required to be reported publicly.  The SEC has proposed separate rules to implement this requirement, which will likely provide additional insight to companies regarding how institutional investors voted on the new shareholder advisory votes.

Getting Prepared

To prepare for the new shareholder advisory votes and related disclosure requirements, companies should consider the following: 

  • Review shareholder base.  Implementation of the new rules provides an opportunity for a company to re-examine the composition of its shareholder base (e.g., institutional vs. retail investors).  In particular, a company should consider whether any of the company’s key shareholders have expressed concerns over the company’s compensation policies or practices, or publicly announced their position regarding say-on-frequency votes.  In addition, the company may wish to consult with its proxy solicitor, or engage a proxy solicitor, in preparation for its upcoming annual meeting. 
  • Focus on executive compensation disclosure.  The inclusion of the say-on-pay and say-on-frequency votes in this year’s proxy statement will heighten the importance of a company’s executive compensation disclosure.  In particular, a company should review its CD&A to ensure that its compensation practices and policies are accurately described and are easily understandable to a reader of the proxy statement.  In addition, to the extent applicable, the company should ensure that its disclosure discusses the company’s performance and the links between such performance and executive pay.  Companies also may wish to consider including an executive summary to their CD&A if they do not already do so.   
  • Develop language for advisory votes.  The SEC did not prescribe any specific language for the say-on-pay and say-on-frequency votes to be included in this year’s proxy statement.  As such, a company has some flexibility in developing the language for these proposals and the related supporting statements. 
  • Determine frequency recommendation.  A board of directors should consider the frequency recommendation that it wishes to include in the company’s proxy statement.  In making a frequency recommendation, a company should consider the pros and cons of annual vs. biennial/triennial say-on-pay votes and which frequency would best suit the company and its compensation policies and practices.  In addition, a company should consider the publicly announced preferences/policies of institutional investors and proxy advisory services on say on frequency.  For instance, several prominent proxy advisory services have advocated for say-on-pay votes on an annual basis. 
  • Monitor early proxy statement filings and voting results.  Companies may wish to consider the proxy statement filings of other similarly situated companies, especially with regard to the say-on-frequency vote.  According to recently published survey data regarding proxy statements filed to date, a majority of those proxy statements included a recommendation for a triennial vote, with an annual vote being the second most popular recommendation.  It should be noted, however, that several of the companies that recommended a triennial vote have reported voting results for their meetings in which a majority of shareholders instead voted for an annual say-on-pay vote.    
  • Develop post-vote communications plan.  It is likely that a company will need to reach out to its shareholders to obtain additional feedback in determining how to respond to the results of the say-on-pay and say-on-frequency votes.  Companies should consider developing a plan to facilitate post-vote communications with their shareholders as part of their annual meeting preparations.  
  • Consider whether to include golden parachute disclosure in proxy statement.  Companies will not be required to include a say-on-golden parachutes vote in connection with the approval of a transaction if the golden parachute arrangements were the subject of a prior say-on-pay vote.  A company wishing to avail itself of this exception could voluntarily provide the prescribed golden parachute disclosure with its other executive compensation disclosure in its annual meeting proxy statement.  It is unlikely, however, that most companies will be able to avoid a say-on-golden parachutes vote in connection with the solicitation of proxies to approve a transaction because any changes to their golden parachute arrangements prior to that time (which could include annual equity grants or pay raises in the ordinary course) will necessitate a new vote. 

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Please note that this Advisory does not necessarily describe the specific impact of the SEC rules summarized above on voluntary filers, foreign private issuers, asset-backed issuers, registered investment companies and others subject to unique requirements.